Philippines Banker Worries About Hot Money

The Philippines’ central bank governor is worried that strong flows of global capital into the nation’s fast-growing economy is complicating his job of fighting inflation.

The Southeast Asian economy is set to expand 6.5% this year, only slightly slower than China, propelled by strong consumption, remittances from overseas workers and infrastructure spending. Foreign capital has flowed in since February, pushing the peso higher and stocks to a record year high this month.

Now, inflation is becoming a growing issue, as the economy reaches supply constraints and foreign capital, searching for higher yields amid still-low U.S. returns, comes pouring into the economy.

But Amando Tetangco, the central bank governor, is reluctant to raise interest rates, worrying this will only attract more speculative capital and worsen the inflationary pressures.

“Textbook would say if there are capital inflows, liquidity will tend to go up and, to limit the growth of liquidity, raise interest rates — you tighten,” Mr. Tetangco said in an interview on the sidelines of the World Economic Forum’s East Asia meeting in Manila.

“But if you do that what will happen is that you’ll attract more capital because of the interest-rate arbitrage given that capital markets are more integrated.”

Mr. Tetangco’s remarks underscore how aggressive monetary easing by central banks in the world’s largest economies has complicated life for policy makers in smaller emerging economies by flooding them with cheap capital.

India’s central bank chief, Raghuram Rajan, has been especially vocal about the need for central banks to coordinate to stop such abrupt flows of money. Central banks are supposed to raise rates to cool their economies, but in a world of super low interest rates, many worry doing so will make their stocks and bonds even more attractive to hot money.

The Philippines solution? Instead use other measures to rein in inflation pressures, including raising the amount of cash commercial banks must hold on reserve rather than lend out.

Mr. Tetangco didn’t rule out a rate hike if inflation continues to build. The Bangko Sentral ng Pilipinas predicts that inflation this year will rise to 4.3% from 3% last year, still within its targeted range for inflation between 3% and 5%.

The Philippines’ official interest rate is at a record low 3.5%. That means that real interest rates are negative – money lent today will be buy less when it is repaid in a year’s time.

That’s normally a recipe for higher inflation and a signal the central bank should raise interest rates to prevent it.

The Philippines has seen what Mr. Tetangco called massive capital inflows since the U.S. Federal Reserve cut rates and began pushing massive liquidity into the global financial system after the global financial crisis. That’s buoyed Philippine stocks and bonds, but also pushed the supply of money in the economy up 30% year-on-year.

The International Monetary warned last year the increased funds in the system could fuel demand for real estate and create risks for financial stability.

Rather than raise rates, the Philippine central bank has raised the proportion of deposits commercial banks must keep on hand – the reserve requirement – and banned foreign funds from putting capital in special deposit accounts at the central bank.

Such limited capital controls have become more accepted in recent years as cross-border financial flows have grown.

Mr. Tetangco said the outlook for the Philippines’ economy remains strong. The government has low debt, allowing it to boost infrastructure spending. Despite its recent growth, the country is poorer than many of its Asian peers, and infrastructure bottlenecks are a problem.

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